The European Central Bank stands ready to act to fight the low inflation within the euro area. The next ECB meeting on June 5th could be one of the decisive moments in the market this year.
Mario Draghi when questioned stated unexpectedly that the 'ECB would be comfortable acting in June' regarding interest rates. The comment led to a major re-pricing of the yield curve as traders started to factor in possible central bank action. The comments took place in the Q&A session of a monthly press conference directly after the interest rate decision.
What could the ECB do?
The ECB has a number of tools at its disposal should the central bank decide to act. The most probable outcome is that there will be an interest rate cut to one or all of the main refinancing, marginal lending and deposit rate. The main refinancing rate which is the head line rate currently stands at 0.25%. The Deposit rate is at 0% but could be pushed negative.
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The effect of this would be to charge banks to deposit money with the ECB with the goal of forcing the commercial institutions that sit on money to lend to small businesses and help kick start the ailing economy which could in theory foster growth and inflation.
As well as this the European Central Bank could restart its cheap loan policy in an attempt to flood markets with excess liquidity and again spur lending.
The final most controversial option would be to engage in its own form of quantitative easing. Mario Draghi has already stated that the ECB have discussed all non standard measures including printing money to buy assets however, this is seen as the least likely outcome given the complexity of such an operation.
The overall outlook for euro zone interest rates going forward has changed from what was priced in a month ago. According to a recent Reuter's survey, The European Central Bank will cut its main interest rate to 0.1% from 0.25% next week and push the deposit rate below zero in an attempt to stop the euro from rising and inflation from falling any further.
As well as this some analysts are arguing that the ECB could see a return to its long term refinancing operation, where money is pumped into the market in the form of cheap loans. The goal of this is to stir lending and investment and push growth and inflation.
The impact of any move by the ECB is likely to be met by a mixed response if the majority of analysts are to be believed.
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"The ECB will cut its deposit rate only to follow up on their promise last month and not disrupt markets," said a money market trader at one of the biggest European dealers.
Whether or not there will be a long term weakening is still up for debate and will be linked to what Draghi follows up with in his press conference. If he continues to highlight actual measures that could be used, the currency could weaken somewhat but after already falling from the 1.40 handle down to 1.36 most are arguing that there would need to be a firm commitment in order to push the value of the EUR down further.
Join tradimo's professional traders in the Trading Classroom on June 5th
This live event with be covered throughout the day by Steve Ruffley and Jack Inman. Jack will be covering the preview of the ECB announcement and Steve will be trading it live in a so-called Live Trading Classroom.
Register at www.tradimo.com to join the event.